Hudson the monster; how a gang of predatory lenders and wall street bankers fleeced america and spawned a global crisis (2010)

RolandArnall’s first subprime lender had been Long Beach Savings and Loan, a company he had morphedinto Long Beach Mortgage.. A salesman from Long Beach Mortgage, Pittman said, told her

To anyone who’s ever been broke, busted, ripped off, cleaned out,

or drowning in debt

“Stuff happens.”

—ROLAND ARNALL, 1939–2008

4 Kill the Enemy

5 The Big Spin

Introduction: Bait and Switch

A few weeks after he started working at Ameriquest Mortgage, Mark Glover looked up from his

cubicle and saw a coworker do something odd The guy stood at his desk on the twenty-third floor ofdowntown Los Angeles’s Union Bank Building He placed two sheets of paper against the window.Then he used the light streaming through the window to trace something from one piece of paper toanother Somebody’s signature

Glover was new to the mortgage business He was twenty-nine and hadn’t held a steady job inyears But he wasn’t stupid He knew about financial sleight of hand—at that time, he had a check-fraud charge hanging over his head in the L.A courthouse a few blocks away Watching his coworker,Glover’s first thought was: How can I get away with that? As a loan officer at Ameriquest, Gloverworked on commission He knew the only way to earn the six-figure income Ameriquest had

promised him was to come up with tricks for pushing deals through the mortgage-financing pipelinethat began with Ameriquest and extended through Wall Street’s most respected investment houses

Glover and the other twentysomethings who filled the sales force at the downtown L.A branchworked the phones hour after hour, calling strangers and trying to talk them into refinancing their

homes with high-priced “subprime” mortgages It was 2003, subprime was on the rise, and

Ameriquest was leading the way The company’s owner, Roland Arnall, had in many ways been thefounding father of subprime, the business of lending money to homeowners with modest incomes orblemished credit histories He had pioneered this risky segment of the mortgage market amid the

wreckage of the savings and loan disaster and helped transform his company’s headquarters, OrangeCounty, California, into the capital of the subprime industry Now, with the housing market boomingand Wall Street clamoring to invest in subprime, Ameriquest was growing with startling velocity

Up and down the line, from loan officers to regional managers and vice presidents, Ameriquest’semployees scrambled at the end of each month to push through as many loans as possible, to pad theirmonthly production numbers, boost their commissions, and meet Roland Arnall’s expectations Arnallwas a man “obsessed with loan volume,” former aides recalled, a mortgage entrepreneur who

believed “volume solved all problems.” Whenever an underling suggested a goal for loan productionover a particular time span, Arnall’s favorite reply was: “We can do twice that.” Close to midnightPacific time on the last business day of each month, the phone would ring at Arnall’s home in LosAngeles’s exclusive Holmby Hills neighborhood, a $30 million estate that once had been home toSonny and Cher On the other end of the telephone line, a vice president in Orange County wouldreport the month’s production numbers for his lending empire Even as the totals grew to $3 billion or

$6 billion or $7 billion a month—figures never before imagined in the subprime business—Arnallwasn’t satisfied He wanted more “He would just try to make you stretch beyond what you thoughtpossible,” one former Ameriquest executive recalled “Whatever you did, no matter how good youdid, it wasn’t good enough.”

Inside Glover’s branch, loan officers kept up with the demand to produce by guzzling Red Bullenergy drinks, a favorite caffeine pick-me-up for hardworking salesmen throughout the mortgage

industry Government investigators would later joke that they could gauge how dirty a home-loanlocation was by the number of empty Red Bull cans in the Dumpster out back Some of the crew in theL.A branch, Glover said, also relied on cocaine to keep themselves going, snorting lines in

washrooms and, on occasion, in their cubicles.

The wayward behavior didn’t stop with drugs Glover learned that his colleague’s art workwasn’t a matter of saving a borrower the hassle of coming in to supply a missed signature The guywas forging borrowers’ signatures on government-required disclosure forms, the ones that were

supposed to help consumers understand how much cash they’d be getting out of the loan and howmuch they’d be paying in interest and fees Ameriquest’s deals were so overpriced and loaded withnasty surprises that getting customers to sign often required an elaborate web of psychological ploys,outright lies, and falsified papers “Every closing that we had really was a bait and switch,” a loanofficer who worked for Ameriquest in Tampa, Florida, recalled “’Cause you could never get them tothe table if you were honest.” At company-wide gatherings, Ameriquest’s managers and sales repsloosened up with free alcohol and swapped tips for fooling borrowers and cooking up phony

paperwork What if a customer insisted he wanted a fixed-rate loan, but you could make more money

by selling him an adjustable-rate one? No problem Many Ameriquest salespeople learned to position

a few fixed-rate loan documents at the top of the stack of paperwork to be signed by the borrower.They buried the real documents—the ones indicating the loan had an adjustable rate that would rocketupward in two or three years—near the bottom of the pile Then, after the borrower had flipped fromsignature line to signature line, scribbling his consent across the entire stack, and gone home, it waseasy enough to peel the fixed-rate documents off the top and throw them in the trash

At the downtown L.A branch, some of Glover’s coworkers had a flair for creative

documentation They used scissors, tape, Wite-Out, and a photocopier to fabricate W-2s, the tax

forms that indicate how much a wage earner makes each year It was easy: Paste the name of a earning borrower onto a W-2 belonging to a higher-earning borrower and, like magic, a bad loanprospect suddenly looked much better Workers in the branch equipped the office’s break room withall the tools they needed to manufacture and manipulate official documents They dubbed it the “ArtDepartment.”

low-At first, Glover thought the branch might be a rogue office struggling to keep up with the goalsset by Ameriquest’s headquarters He discovered that wasn’t the case when he transferred to the

company’s Santa Monica branch A few of his new colleagues invited him on a field trip to Staples,where everyone chipped in their own money to buy a state-of-the-art scanner-printer, a trusty piece ofequipment that would allow them to do a better job of creating phony paperwork and trapping

American homeowners in a cycle of crushing debt

Carolyn Pittman was an easy target She’d dropped out of high school to go to work, and had neverlearned to read or write very well She worked for decades as a nursing assistant Her husband,

Charlie, was a longshoreman In 1993 she and Charlie borrowed $58,850 to buy a one-story, concreteblock house on Irex Street in a working-class neighborhood of Atlantic Beach, a community of

thirteen thousand near Jacksonville, Florida Their mortgage was government-insured by the FederalHousing Administration, so they got a good deal on the loan They paid about $500 a month on theFHA loan, including the money to cover their home insurance and property taxes

Even after Charlie died in 1998, Pittman kept up with her house payments But things were toughfor her Financial matters weren’t something she knew much about Charlie had always handled what

little money they had Her health wasn’t good either She had a heart attack in 2001, and was back andforth to hospitals with congestive heart failure and kidney problems.

Like many older black women who owned their homes but had modest incomes, Pittman wasdeluged almost every day, by mail and by phone, with sales pitches offering money to fix up her house

or pay off her bills A few months after her heart attack, a salesman from Ameriquest Mortgage’sCoral Springs office caught her on the phone and assured her he could ease her worries He said

Ameriquest would help her out by lowering her interest rate and her monthly payments

She signed the papers in August 2001 Only later did she discover that the loan wasn’t whatshe’d been promised Her interest rate jumped from a fixed 8.43 percent on the FHA loan to a

variable rate that started at nearly 11 percent and could climb much higher The loan was also packedwith more than $7,000 in up-front fees, roughly 10 percent of the loan amount

Pittman’s mortgage payment climbed to $644 a month Even worse, the new mortgage didn’tinclude an escrow for real-estate taxes and insurance Most mortgage agreements require

homeowners to pay a bit extra—often about $100 to $300 a month—which is set aside in an escrowaccount to cover these expenses But many subprime lenders obscured the true costs of their loans byexcluding the escrow from their deals, which made the monthly payments appear lower Many

borrowers didn’t learn they had been tricked until they got a big bill for unpaid taxes or insurance ayear down the road

That was just the start of Pittman’s mortgage problems Her new mortgage was a matter of

public record, and by taking out a loan from Ameriquest, she’d signaled to other subprime lendersthat she was vulnerable—that she was financially unsophisticated and was struggling to pay an

unaffordable loan In 2003, she heard from one of Ameriquest’s competitors, Long Beach MortgageCompany

Pittman had no idea that Long Beach and Ameriquest shared the same corporate DNA RolandArnall’s first subprime lender had been Long Beach Savings and Loan, a company he had morphedinto Long Beach Mortgage He had sold off most of Long Beach Mortgage in 1997, but hung on to aportion of the company that he rechristened Ameriquest Though Long Beach and Ameriquest were nolonger connected, both were still staffed with employees who had learned the business under Arnall

A salesman from Long Beach Mortgage, Pittman said, told her that he could help her solve theproblems created by her Ameriquest loan Once again, she signed the papers The new loan fromLong Beach cost her thousands in up-front fees and boosted her mortgage payments to $672 a month

Ameriquest reclaimed her as a customer less than a year later A salesman from Ameriquest’sJacksonville branch got her on the phone in the spring of 2004 He promised, once again, that

refinancing would lower her interest rate and her monthly payments Pittman wasn’t sure what to do.She knew she’d been burned before, but she desperately wanted to find a way to pay off the LongBeach loan and regain her financial bearings She was still pondering whether to take the loan whentwo Ameriquest representatives appeared at the house on Irex Street They brought a stack of

documents with them They told her, she later recalled, that it was preliminary paperwork, simply toget the process started She could make up her mind later The men said, “sign here,” “sign here,”

“sign here,” as they flipped through the stack Pittman didn’t understand these were final loan papersand her signatures were binding her to Ameriquest “They just said sign some papers and we’ll helpyou,” she recalled

To push the deal through and make it look better to investors on Wall Street, consumer attorneyslater alleged, someone at Ameriquest falsified Pittman’s income on the mortgage application At best,she had an income of $1,600 a month—roughly $1,000 from Social Security and, when he could

afford to pay, another $600 a month in rent from her son Ameriquest’s paperwork claimed she

brought in more than twice that much—$3,700 a month

The new deal left her with a house payment of $1,069 a month—nearly all of her monthly

income and twice what she’d been paying on the FHA loan before Ameriquest and Long Beach

hustled her through the series of refinancings She was shocked when she realized she was required topay more than $1,000 a month on her mortgage “That broke my heart,” she said

For Ameriquest, the fact that Pittman couldn’t afford the payments was of little consequence Herloan was quickly pooled, with more than fifteen thousand other Ameriquest loans from around thecountry, into a $2.4 billion “mortgage-backed securities” deal known as Ameriquest Mortgage

Securities, Inc Mortgage Pass-Through Certificates 2004-R7 The deal had been put together by atrio of the world’s largest investment banks: UBS, JPMorgan, and Citigroup These banks oversawthe accounting wizardry that transformed Pittman’s mortgage and thousands of other subprime loansinto investments sought after by some of the world’s biggest investors Slices of 2004-R7 got snapped

up by giants such as the insurer MassMutual and Legg Mason, a mutual fund manager with clients inmore than seventy-five countries Also among the buyers was the investment bank Morgan Stanley,which purchased some of the securities and placed them in its Limited Duration Investment Fund,mixing them with investments in General Mills, FedEx, JC Penney, Harley-Davidson, and other

household names

It was the new way of Wall Street The loan on Carolyn Pittman’s one-story house in AtlanticBeach was now part of the great global mortgage machine It helped swell the portfolios of big-timespeculators and middle-class investors looking to build a nest egg for retirement And, in doing so, ithelped fuel the mortgage empire that in 2004 produced $1.3 billion in profits for Roland Arnall

In the first years of the twenty-first century, Ameriquest Mortgage unleashed an army of salespeople

on America They numbered in the thousands They were young, hungry, and relentless in their drive

to sell loans and earn big commissions One Ameriquest manager summed things up in an e-mail tohis sales force: “We are all here to make as much fucking money as possible Bottom line Nothingelse matters.” Homeowners like Carolyn Pittman were caught up in Ameriquest’s push to become thenation’s biggest subprime lender

The pressure to produce an ever-growing volume of loans came from the top Executives at

Ameriquest’s home office in Orange County leaned on the regional and area managers; the regionaland area managers leaned on the branch managers And the branch managers leaned on the salesmenwho worked the phones and hunted for borrowers willing to sign on to Ameriquest loans Men

usually ran things, and a frat-house mentality ruled, with plenty of partying and testosterone-fueledswagger “It was like college, but with lots of money and power,” Travis Paules, a former

Ameriquest executive, said Paules liked to hire strippers to reward his sales reps for working wellafter midnight to get loan deals processed during the end-of-the-month rush At Ameriquest branchesaround the nation, loan officers worked ten-and twelve-hour days punctuated by “Power Hours”—do-or-die telemarketing sessions aimed at sniffing out borrowers and separating the real salesmen fromthe washouts At the branch where Mark Bomchill worked in suburban Minneapolis, managementexpected Bomchill and other loan officers to make one hundred to two hundred sales calls a day One

manager, Bomchill said, prowled the aisles between desks like “a little Hitler,” hounding salesmen tomake more calls and sell more loans and bragging he hired and fired people so fast that one peonwould be cleaning out his desk as his replacement came through the door As with Mark Glover inLos Angeles, experience in the mortgage business wasn’t a prerequisite for getting hired Formeremployees said the company preferred to hire younger, inexperienced workers because it was easier

to train them to do things the Ameriquest way A former loan officer who worked for Ameriquest inMichigan described the company’s business model this way: “People entrusting their entire home andeverything they’ve worked for in their life to people who have just walked in off the street and don’tknow anything about mortgages and are trying to do anything they can to take advantage of them.”

Ameriquest was not alone Other companies, eager to get a piece of the market for high-profitloans, copied its methods, setting up shop in Orange County and helping to transform the county intothe Silicon Valley of subprime lending With big investors willing to pay top dollar for assets backed

by this new breed of mortgages, the push to make more and more loans reached a frenzy among thecounty’s subprime loan shops “The atmosphere was like this giant cocaine party you see on TV,”said Sylvia Vega-Sutfin, who worked as an account executive at BNC Mortgage, a fast-growing

operation headquartered in Orange County just down the Costa Mesa Freeway from Ameriquest’sheadquarters “It was like this giant rush of urgency.” One manager told Vega-Sutfin and her

coworkers that there was no turning back; he had no choice but to push for mind-blowing productionnumbers “I have to close thirty loans a month,” he said, “because that’s what my family’s lifestyledemands.”

Michelle Seymour, one of Vega-Sutfin’s colleagues, spotted her first suspect loan days after shebegan working as a mortgage underwriter at BNC’s Sacramento branch in early 2005 The documents

in the file indicated the borrower was making a six-figure salary coordinating dances at a Mexicanrestaurant All the numbers on the borrower’s W-2 tax form ended in zeros—an unlikely

happenstance—and the Social Security and tax bite didn’t match the borrower’s income When

Seymour complained to a manager, she said, he was blasé, telling her, “It takes a lot to have a loandeclined.”

BNC was no fly-by-night operation It was owned by one of Wall Street’s most storied

investment banks, Lehman Brothers The bank had made a big bet on housing and mortgages, stylingitself as a player in commercial real estate and, especially, subprime lending “In the mortgage

business, we used to say, ‘All roads lead to Lehman,’” one industry veteran recalled Lehman hadbought a stake in BNC in 2000 and had taken full ownership in 2004, figuring it could earn even moremoney in the subprime business by cutting out the middleman Wall Street bankers and investors

flocked to the loans produced by BNC, Ameriquest, and other subprime operators; the steep fees andinterest rates extracted from borrowers allowed the bankers to charge fat commissions for packagingthe securities and provided generous yields for investors who purchased them Up-front fees on

subprime loans totaled thousands of dollars Interest rates often started out deceptively low—perhaps

at 7 or 8 percent—but they almost always adjusted upward, rising to 10 percent, 12 percent, andbeyond When their rates spiked, borrowers’ monthly payments increased, too, often climbing byhundreds of dollars Borrowers who tried to escape overpriced loans by refinancing into anothermortgage usually found themselves paying thousands of dollars more in backend fees—“prepaymentpenalties” that punished them for paying off their loans early Millions of these loans—tied to modesthomes in places like Atlantic Beach, Florida; Saginaw, Michigan; and East San Jose, California—helped generate great fortunes for financiers and investors They also helped lay America’s economylow and sparked a worldwide financial crisis

The subprime market did not cause the U.S and global financial meltdowns by itself Other

varieties of home loans and a host of arcane financial innovations—such as collateralized debt

obligations and credit default swaps—also came into play Nevertheless, subprime played a centralrole in the debacle It served as an early proving ground for financial engineers who sold investorsand regulators alike on the idea that it was possible, through accounting alchemy, to turn risky assetsinto “Triple-A-rated” securities that were nearly as safe as government bonds In turn, financial

wizards making bets with CDOs and credit default swaps used subprime mortgages as the raw

material for their speculations Subprime, as one market watcher said, was “the leading edge of afinancial hurricane.”

This book tells the story of the rise and fall of subprime by chronicling the rise and fall of two

corporate empires: Ameriquest and Lehman Brothers It is a story about the melding of two financialcultures separated by a continent: Orange County and Wall Street

Ameriquest and its strongest competitors in subprime had their roots in Orange County, a sunnyland of beauty and wealth that has a history as a breeding ground for white-collar crime: boiler

rooms, S&L frauds, real-estate swindles That history made it an ideal setting for launching the

subprime industry, which grew in large measure thanks to bait-and-switch salesmanship and variety deception By the height of the nation’s mortgage boom, Orange County was home to four ofthe nation’s six biggest subprime lenders Together, these four lenders—Ameriquest, Option One,Fremont Investment & Loan, and New Century—accounted for nearly a third of the subprime market.Other subprime shops, too, sprung up throughout the county, many of them started by former

garden-employees of Ameriquest and its corporate forebears, Long Beach Savings and Long Beach

Mortgage

Lehman Brothers was, of course, one of the most important institutions on Wall Street, a firmwith a rich history dating to before the Civil War Under its pugnacious CEO, Richard Fuld, Lehmanhelped bankroll many of the nation’s shadiest subprime lenders, including Ameriquest “Lehman

never saw a subprime lender they didn’t like,” one consumer lawyer who fought the industry’s abusessaid Lehman and other Wall Street powers provided the financial backing and sheen of respectabilitythat transformed subprime from a tiny corner of the mortgage market into an economic behemoth

capable of triggering the worst economic crisis since the Great Depression

A long list of mortgage entrepreneurs and Wall Street bankers cultivated the tactics that fueledsubprime’s growth and its collapse, and a succession of politicians and regulators looked the otherway as abuses flourished and the nation lurched toward disaster: Angelo Mozilo and CountrywideFinancial; Bear Stearns, Washington Mutual, Wells Fargo; Alan Greenspan and the Federal Reserve;and many more Still, no Wall Street firm did more than Lehman to create the subprime monster And

no figure or institution did more to bring subprime’s abuses to life across the nation than Roland

Arnall and Ameriquest

Among his employees, subprime’s founding father was feared and admired He was a figure ofrumor and speculation, a mysterious billionaire with a rags-to-riches backstory, a hardscrabble streetvendor who reinvented himself as a big-time real-estate developer, a corporate titan, a friend to many

of the nation’s most powerful elected leaders He was a man driven, according to some who knew

him, by a desire to conquer and dominate “Roland could be the biggest bastard in the world and themost charming guy in the world,” said one executive who worked for Arnall in subprime’s earlydays “And it could be minutes apart.” He displayed his charm to people who had the power to helphim or hurt him He cultivated friendships with politicians as well as civil rights advocates and

antipoverty crusaders who might be hostile to the unconventional loans his companies sold in

minority and working-class neighborhoods Many people who knew him saw him as a visionary, ahumanitarian, a friend to the needy “Roland was one of the most generous people I have ever met,” aformer business partner said He also left behind, as another former associate put it, “a trail of

bodies”—a succession of employees, friends, relatives, and business partners who said he had

betrayed them In summing up his own split with Arnall, his best friend and longtime business partnersaid, “I was screwed.” Another former colleague, a man who helped Arnall give birth to the modernsubprime mortgage industry, said: “Deep down inside he was a good man But he had an evil side.When he pulled that out, it was bad He could be extremely cruel.” When they parted ways, he said,Arnall hadn’t paid him all the money he was owed But, he noted, Arnall hadn’t cheated him as badly

as he could have “He fucked me But within reason.”

Roland Arnall built a company that became a household name, but shunned the limelight forhimself The business partner who said Arnall had “screwed” him recalled that Arnall fancied

himself a puppet master who manipulated great wealth and controlled a network of confederates toperform his bidding Another former business associate, an underling who admired him, explainedthat Arnall worked to ingratiate himself to fair-lending activists for a simple reason: “You can take

that straight out of The Godfather: ‘Keep your enemies close.’”

1 Godfather

In his early years as a businessman, Roland Arnall didn’t give much thought to the home-loan

business He was a real-estate developer He preferred big deals that measured in the tens of

millions: shopping centers, apartment complexes, commercial loans As the owner of a savings andloan in the 1980s, he channeled his institution’s deposits into his own real-estate projects and loans tofellow developers By the middle of the decade, however, Arnall could no longer insulate his LosAngeles County–based operation, Long Beach Savings and Loan, from the fallout of the S&L debacle

As bad loans on shopping malls and high-rises pushed many S&Ls into insolvency, regulators beganplacing limits on how much money the institutions could risk on large commercial investments Theregulators pushed Arnall to diversify Long Beach’s holdings

Arnall complained that the bureaucrats didn’t understand how things worked in the real world

“He hated the regulators,” one former aide recalled “He couldn’t understand their constant meddling

in his affairs.” Arnall knew, though, that he needed to get them off his back He hired an employmentconsultant to find someone to start a home-mortgage division at Long Beach Savings The headhuntergot in touch with Mark Schuerman, a banking consultant in Orange County Schuerman had a longrésumé in the lending business His father had run a small consumer-finance company in Indiana Inthe 1970s, Schuerman himself had worked for Advance Mortgage, Citibank’s mortgage banking

division

Over lunch, Arnall asked Schuerman if he would be willing to run a residential mortgage

operation for Long Beach Savings, making first mortgages to borrowers with good credit Arnall saidall the right things: he would leave Schuerman alone to run his own shop Schuerman could have anopen checkbook to spend whatever it took to make the business take off Schuerman could have afive-year contract and a piece of the action; if the mortgage division did well, Schuerman would dowell, too Schuerman liked Arnall He was smart, engaging, persuasive But one thing worried

Schuerman: Arnall’s zeal for growth Arnall seemed a bit like a child, unable to understand that somethings take time “How soon can we get to a billion dollars a month?” Arnall prodded Schuermanwas taken aback Citibank, the nation’s biggest mortgage lender, was doing barely $1.1 billion a

month in home-loan volume To think that a start-up lender could quickly get to that level was

foolhardy, Schuerman thought He could see that, if he went to work for Long Beach, Arnall was

going to “have a foot up my ass every day.”

Soon after, Schuerman phoned Arnall to tell him he was interested in the job, but he couldn’texpand the new division as fast as Arnall wanted and still do things right “I don’t work miracles I

do loans We can grow it, but we’ve got to have a foundation.” Schuerman wasn’t going to risk hisreputation by pushing growth too far, too fast In the mortgage business, he knew, this would be arecipe for disaster Lenders that lowered their standards in an effort to grow quickly often ended upwith sizeable losses from loan delinquencies and foreclosures

Arnall backed off Of course, he said, he wanted to build a solid base before ratcheting up loanvolume He invited Schuerman to meet again, and they worked out a deal As they made plans to getstarted, Arnall readily agreed to Schuerman’s proposal that they base the home-loan division in

Orange County rather than Long Beach The location Schuerman picked, Town and Country Road inthe city of Orange, was just off the Orange Crush, the interchange that brought together the Santa Ana,

Garden Grove, and Orange freeways, not far from John Wayne Airport It was a short commute forSchuerman from his home in Riverside County, avoiding the traffic snarls for which Los Angeles wasfamous It was a good place to locate the new division, too, because the nearby Orange County towns

of Garden Grove and Anaheim, as well as neighboring Riverside County, were relatively low-costplaces to live—making it easy to recruit mortgage talent, particularly the office support staffers

necessary to start up the business

In September 1986, Schuerman began work at Long Beach Savings He was excited about thechallenge, but he and Arnall soon realized their timing was off By the summer of 1987, it was

becoming clear that it was a bad time to be offering conventional “A-credit” mortgage loans Therewere too many big, established players in the market, and price wars had driven profit margins intothe ground Long Beach’s home-loan division struggled to stay above water

Schuerman met Arnall for lunch at Arnall’s members-only dining establishment in Los Angeles,the Regency Club, in the summer of 1987 They agreed something had to change Schuerman suggestedthey convert the mortgage division into a consumer lender focused on second mortgages to peoplewith modest incomes or weak credit histories Arnall was surprised to learn that Schuerman had

some experience selling second mortgages from his time working at Citibank But he loved the idea

As always, he wanted to move fast How soon, he wanted to know, could they open fifty branch

offices?

When it came to building his businesses, Roland Arnall was always in a hurry He had gotten his start

as an entrepreneur as a teenaged immigrant, selling eggs door-to-door in his adopted hometown ofLos Angeles How Southern California came to be his home was a story of war, survival, and exodus

He was the son of Eastern European Jews—his mother, a nurse, was Czech and his father, a tailor,was Romanian, from Transylvania The couple had moved to Paris in the late 1920s As precondition

to marriage, she had insisted he get rid of his Austrian-Hungarian accent It was a difficult task, but hemanaged it His father’s success in shedding his accent “saved our lives,” the son later recalled,

because it allowed the family to avoid scrutiny during World War II

Roland was born in Paris on March 29, 1939 With the German invasion, the Arnalls fled thecapital and took refuge in a village in southern France, Pontles-Bains Like many French Jews duringthe war, the Arnalls avoided detection by the Nazis and their collaborators by hiding their identitiesand living as Catholics One story had Roland becoming an altar boy, or at least dressing as one.Roland didn’t learn he was Jewish until after the end of the war, when he was eight or nine years old.His mother told him she wanted him to learn Hebrew and explained why Most of his relations, helearned, had died in the Holocaust “The next day,” he recalled, “I had my first major fight at school.The boys accused me of having killed Christ.”

He was twelve when his family moved to Montreal in the early 1950s The Arnalls tried to enterthe United States but couldn’t get visas After five years in Canada, they tried again, choosing

California as their destination “My father returned from a family visit to Beverly Hills He said hehad found the place to live A place where there were no poor people,” Arnall said more than a halfcentury later

After the family settled in Los Angeles, Roland began his business selling eggs door-to-door

Then he enlisted his younger brother, Claude, and switched to peddling flowers on street corners.Soon, he expanded, hiring employees to do the selling for him and buying a truck to keep his vendorssupplied Arnall used the profits from his flower business to buy his first home Then he sold thehouse and funneled those profits into buying investment property By his late twenties, he’d

established himself as a real-estate developer, a young man with a distinct accent, oversized rimmed glasses, and an air of earnestness He soon discovered that, in Los Angeles, real estate andpolitics were inseparable If you wanted to get something done—win a zoning variance, speed uppermits, snag a piece of land with untapped potential—you needed friends in positions of power

dark-Arnall made it his mission to cultivate ties with local politicians One of them was Art Snyder, aformer Los Angeles City Council staffer who had been elected to a council seat in 1967 Snyder waspart Irish and part German, a red-haired, red-faced political scrapper whose blue-collar demeanorhelped him win a surprising number of votes in the Latino precincts of his east side district In thedecades to come, Snyder would become known as one of the city’s slickest operators, with

government ethics watchdogs accusing him of hiding cash he had pocketed from a city contractor andlater, as a lobbyist, of creating an elaborate money-laundering system to conceal the source of localcampaign donations Snyder’s relationship with Arnall produced an early controversy in the

politician’s life, as well as a taste of unflattering publicity for the young developer In 1968, Snyderbegan pushing a $6 million housing project proposed by Arnall and his development firm, REA

Companies (REA stood for “Roland E Arnall.”) Arnall wanted to build five hundred homes on land

he had bought from the city Snyder said the project would provide much-needed low-cost housing.Arnall was the only bidder on the tract He paid $75,000 for thirty acres To some, it smelledlike a sweetheart deal Opponents of the project suggested Snyder backed it because Arnall had

contributed $1,000 to his campaign Anthony Rios, a community activist who’d built Latino politicalclout in Los Angeles, feared the project wouldn’t help low-income people at all, but instead squeezethem out of the area by pushing up rents Rios said he had learned Arnall was negotiating with

Prudential Insurance Company to finance the project, and Prudential had been secretly promised azoning change that would make the land more lucrative As the debate flared, a council member

opposed to the deal shouted, in Hollywood style, “You don’t want the truth!”

Arnall’s financing and the zoning change fell through, and, after putting down a $7,500 deposit,

he stiffed the city for the rest of what he owed on the raw land When city officials pointed out hisdelinquency, he explained that he had always intended to pay; he’d simply “goofed” and misread thedue date for the outstanding balance on the purchase price He wrote a check for what he owed

Six months later, though, Snyder went back to the city council and reopened the controversy Heasked the city to take the land back Now that his construction plans had run aground, Arnall hadcreditors breathing down his neck The land was useless to him and he needed the money Councilmembers bickered anew over this latest wrinkle Then they rejected Snyder’s plea to bail Arnall out

The failed housing venture didn’t slow Arnall down Real estate, he knew, is a gambler’s game Thebest players understand that reversals of fortune are a fact of life for any developer, and the best way

to weather such misadventures is to play with other people’s money “Real-estate development is afunction of the availability of money And the availability of money is a function of the stupidity of

lenders,” one builder in Atlanta, Georgia, told Martin Mayer, the dean of American business writers,

in the late 1970s Developers are always hungry for more financing and bigger deals; pulling backafter a stumble is rarely an option “If there’s money available, they’ll build and develop whetherthere’s a need for it or not,” a former Arnall business associate said Maintaining an illusion of

success and clout is crucial to keeping the money flowing and enduring the ups and downs

Throughout the ’70s, Arnall lived a double life He ate in the best restaurants, lived in Los

Angeles’s prosperous Hancock Park neighborhood, courted the city’s power brokers He spreadmoney among many of California’s top Democrats He was friendly with the city’s trailblazing

African-American mayor, Tom Bradley He supported Governor Edmund G “Jerry” Brown Jr.’sreelection with a $25,000 loan All the while, Arnall was fighting to stay afloat, flirting with

bankruptcy and borrowing money to keep his business solvent For a time, Arnall teamed with

Beverly Hills Bancorp, with the bank providing the financing and Arnall scouting for the land andputting the deals together In 1974, the bank filed for bankruptcy, under pressure from federal

securities cops and investors who claimed it had defaulted on obligations Arnall and REA

Companies weren’t part of the investigation, but the bank’s fall left him without a reliable fundingpartner He came close to losing everything He recovered, as he often did, by coaxing more loans out

of friends and associates One friend who provided last-ditch loans recalled that Arnall nearly wentunder three or four times in those years

As the decade came to a close, Arnall decided to change his fortunes He filed an application toopen an S&L, Long Beach Savings and Loan At the dawn of the Reagan era, it was relatively easy toopen an S&L, or “thrift” as they were often called S&Ls had their origins as building and loan

societies founded to help average folks achieve the dream of homeownership For much of their

history, they distinguished themselves from banks by accepting savings deposits and providing homemortgages but not offering checking accounts or making business loans In theory, at least, they weresupposed to be the kind of community-based and community-minded institutions immortalized by

Jimmy Stewart’s role as George Bailey, president of the Bailey Building and Loan, in It’s a

regulations that had governed the industry State governments also got into the deregulatory spirit,competing with one another in offering the lowest barriers to entry for founding S&Ls as well as themost lenient oversight once institutions were established This shredding of financial regulation

gained speed after Ronald Reagan took office in 1981 When he signed an S&L deregulation bill intolaw in the White House Rose Garden in 1982, Reagan quipped, “All in all, I think we hit the

jackpot.”

The new rules allowed S&Ls to invest heavily in shopping malls, high-rises, and other

speculative projects and to bankroll real-estate deals that did not require down payments from theborrowers The rules also made it possible for a single investor to own an S&L What’s more,

budding S&L impresarios didn’t need to pony up much money as start-up capital; instead, they could

list “non-cash” assets as evidence that they had the capital cushion to operate in a stable manner Thisallowed entrepreneurs to use undeveloped land to capitalize new thrifts Lots of developers joinedArnall in the rush into the thrift business, especially in California, where lax regulations made it

ridiculously easy to obtain an S&L charter Consultants and law firms made money by offering

seminars on how to open a savings and loan, including one titled, “Why Does It Seem Everyone IsBuying or Starting a California S&L?” The new breed of S&L proprietors plowed money into allmanner of investments: junk bonds, hotels, mushroom ranches, windmill farms, tanning beds, Arabianhorses

Long Beach Savings took chances, bankrolling Arnall’s real-estate deals, including strip mallsand larger shopping centers Arnall even tried to put together a chain of car washes, but got out ofcar-wash franchising after realizing it was rife with corruption; as a cash-only business, it was easyfor on-site managers to skim away most of the profits A car-wash operator shocked one of Arnall’saides, Bob Labrador, by unlocking the trunk of his Cadillac and revealing boxes piled high with loosecash Arnall had no interest in putting himself in a position that allowed others to filch profits fromhim

Long Beach’s biggest business was making large commercial loans to other entrepreneurs

Commercial real-estate loans are usually riskier than single-family home loans Arnall, though, had anadvantage over most existing S&L operators Those companies were financial institutions trying tomake it big in what, to them, was a new endeavor, commercial real estate Long Beach Savings, onthe other hand, was more like a development company masquerading as an S&L Commercial realestate was the world Arnall knew He loved to drive around L.A in his Jaguar and point out the

various projects he’d built or refurbished With a few exceptions, Long Beach Savings did a good job

of picking the projects it agreed to finance Arnall and his staff agonized over which loans to make inthe thrift’s early years

Sometimes, Arnall used his S&L’s commercial lending program to get control of other

developers’ projects He’d identify a project that needed an infusion of credit, for expansion or to fixcash-flow problems He’d come in as a money partner, forming a joint loan venture If he saw anopening—such as a cost overrun—he’d put the screws to his partner and take over the project forhimself Tom Tarter, a Southern California banker who got to know Arnall in the early ’80s, learnedabout Arnall’s modus operandi through contacts in the L.A business community, including one friendwho had received such treatment Arnall’s strategy was confirmed by Bob Labrador, an executive atLong Beach around that time “It wasn’t done in a very overt way—you wouldn’t know it unless youwere a fly on a wall,” Labrador recalled “I learned over time how he operated… He wasn’t like avicious shark about it He just continually worked it to his advantage, until he had the upper hand.”

A lawsuit filed in the 1980s in Los Angeles Superior Court claimed Arnall took his hard-nosedapproach toward business associates even further Six of Arnall’s partners in an investment deal

charged that he had stolen money from them through “intentional fraud.” Arnall had formed VictorySquare Ltd., to buy a multitenant office building in Los Angeles The aggrieved partners asserted thatArnall and another investor played a financial shell game that spirited away $165,000 belonging tothe partnership Arnall’s collaborator, the suit alleged, purchased the property from its owner in early

1982, then sold it at a quick markup to Victory Square, violating his fiduciary duty to the other

partners In court papers, Arnall’s attorneys said the allegations were baseless A judge or jury didn’tget a chance to decide who was in the right; the case was settled on confidential terms in 1987

However it ended, the charges were an early example of what would become a pattern in Arnall’sbusiness career: a deal was struck, Arnall profited, and the other people involved came forward to

claim that Arnall and his allies had used shifty tactics to squeeze them out of money.

For generations, mortgages had been a plain vanilla business People took out mortgages to purchasehomes, borrowing at fixed interest rates over a fixed numbers of years They looked forward to theday when they had paid off their mortgages and owned their homes free and clear Some families heldmortgage-burning parties after they’d made the final payment on their house notes The idea of

borrowing against the family homestead—taking cash out with a second mortgage—was consideredvaguely disreputable, an act of desperation or irresponsibility “The second mortgage category…suffered from a pretty bad reputation,” one credit marketing executive recalled “It generally tended

to be a credit facility of last resort, and was done by people in dire straits.”

During the Reagan years, the financial industry set out to change that mind-set and remake themortgage industry in the bargain Banks and S&Ls inundated American homeowners with junk mailand print advertisements “Don’t sit on your equity,” one ad said “Turn it into cash with our homeequity loan.” Another ad depicted a couple, beaming in front of their home The caption: “We justdiscovered $50,000 hidden in our house!” Marketing executives at Citicorp and its competitors

worked to obscure the stigma carried by second mortgages Homeowners were encouraged to use theextra cash to cover their children’s college tuition or take their dream vacations “Calling it a ‘secondmortgage,’ that’s like hocking your house,” a former Citicorp executive recalled “But call it ‘equityaccess,’ and that sounds more innocent.”

Citicorp and other banks generally marketed these home-equity products to white, middle-classhomeowners with good credit histories Black and Latino homeowners tended to get snubbed,

regardless of their incomes or credit records There were few bank branches located in minorityneighborhoods, and for several decades entire neighborhoods had been deemed too risky for lending,

a practice known as “redlining.” This legacy of discrimination meant that blacks and Latinos oftenhad trouble finding banks willing to lend them money

That vacuum was filled by the forerunners of subprime, a collection of downscale finance companies and “hard-money” mortgage lenders that were happy to troll for customers withweak credit or humble incomes The companies loaned money at steep prices to homeowners whohad few other options The hard-money shops were the ultimate lenders of last resort To them, onething mattered: How much equity had the borrower built up in the property? Credit history and

consumer-income didn’t much matter As long as there was a cushion of equity, the lender would make the loan,secure that if the borrower fell behind, it could foreclose, resell the property, and make a profit—or

at least break even Even in a period of high interest rates—mortgage rates soared well above 10percent at the start of the ’80s, and clung just below 10 percent as the decade ended—hard-moneylenders’ prices were eye-popping It wasn’t unusual for them to charge 20 up-front points in fees andcosts on top of 20 percent interest; mortgage industry hands joked that these were 20/20 mortgages,

“perfect vision loans.”

One of the most insatiable of the hard-money sharks, Virginia-based Landbank Equity

Corporation, promoted its loans through the persona of “Miss Cash.” “When banks say ‘No,’ MissCash says ‘Yes.’” That “yes” came with a steep price Landbank charged an average of 29 percent inorigination and processing fees Two sisters from Salem, Virginia, paid $3,750 in up-front charges to

borrow $7,500 The tactics used by Landbank and similar hard-money lenders went a long way

toward explaining why, over the course of the ’80s, foreclosure rates tripled nationwide

Consumer-finance companies weren’t quite as pricey as hard-money lenders A home loan atone of the national consumer-finance chains, such as Household Finance, ITT Financial, or

Transamerica Financial, might carry 10 up-front points on top of interest rates of 15 to 18 percent.Such price tags allowed the lenders to say, with a straight face, that they were doing customers afavor: they were providing a lower-cost alternative to the hard-money crowd

Consumer-finance companies had traditionally focused on making small personal loans By the

’80s they had moved into the home-equity market, often using small loans to fish for borrowers whocould be cajoled into taking out larger loans using their homes as collateral A customer might comeinto a storefront office and borrow $300 to cover some medical bills Or she might buy a washingmachine on credit from a retailer, which then sold the loan contract to the consumer-finance company.Either way, the finance company peppered these new customers with offers for more money The ideawas to convert short-term borrowers into lifetime customers—to keep people continually in debt bygetting them to take out a new loan before they had paid off the balance on the old one After rollingover customers’ small-scale loans a few times, the finance company often talked them into

transferring the escalating debt into a new mortgage against their homes One industry analyst dubbedthis process “moving up the food chain.” Consumer lawyers who spent their days suing the companieshad another name for this process of serial refinancings packed with high up-front fees: “loan

flipping.”

Consumer-finance companies and hard-money lenders could do much as they pleased, because,

by the early ’80s, state and federal lawmakers had thrown out the restrictions on the kinds of loansmortgage lenders could offer and the prices they could charge This deregulation had been propelled,

in part, by the big banks’ campaign to make home-equity lending respectable “Borrowers at financecompanies are now learning that ‘deregulation’ really means the door is open for abuse,” the majority

leader of the Wisconsin state senate told the Wall Street Journal in 1985 Many consumer-finance

companies became sink-or-swim pressure cookers for employees Senior managers were constantly

on the phone, berating branch managers: Where’s your volume? Why are your collections down? Anexecutive at ITT Financial liked to rank the branches he oversaw by production of new loans Themanager of the top branch for the month won accolades and a bonus The manager of the lowest-

producing was required to keep a lump of rubber dog shit on his desk for the next month, to remindhim of his poor performance The only way to get the off ending dollop off his desk was to sell moreloans

Doing whatever it took to book loans became part of the culture at some finance companies Thenation’s biggest consumer-finance operations—ITT, Household, and Transamerica—set aside

millions to settle class-action lawsuits accusing them of cheating borrowers In Arizona, a judge

scolded Transamerica for trying to throw a seventy-seven-year-old widow out of the home her latehusband had helped her build forty-two years before Lennie Williams, a retired house cleaner, wasgetting by on $438 a month Her mind was failing her, and she got snookered into signing up for amortgage that obligated her to pay Transamerica $499 a month The loan carried 8 points in up-frontcharges and an interest rate of nearly 18 percent The mortgage salesman who put together the deallater testified he didn’t think Williams understood the loan, but he had said as little as possible aboutthe details because he didn’t want to lose the sale

“I didn’t want to bring up the fact that we could foreclose on your home People don’t want tohear this,” he explained “When you close a loan, you try to get through with it You say everything

you have to say and no more.”

Mark Schuerman was aware of the unsavory practices of the hard-money lenders and

consumer-finance companies as he steered Roland Arnall’s S&L into the low-end mortgage business in the lastmonths of 1987 He knew the pitfalls and temptations of the game He wanted, he said, to create anorganization in which employees didn’t feel pressured to cut corners to meet unreasonable sales

goals

Schuerman was an easygoing man with a dry wit He wasn’t the kind of executive who managed

by yelling and belittling “To me, it’s fun and challenging to get people to do what you want and feelgood about it,” he told a reporter during his days at Long Beach “In fact, it’s the only way I know for

a guy like me—who doesn’t have any musical talent—to get a chance to lead an orchestra.”

To build his staff, he hired a couple of fellow Midwesterners, Bob Dubrish and Pat Rank, as histop aides Both were experienced consumer-finance hands They’d worked together at ITT Financial.Dubrish had played tight end in the University of Illinois’s power-house football program He wastall, likeable, and soft-spoken, a savvy manager and a good salesman Rank was tall, hardworking,and sharp-tongued Rank, Schuerman learned, said what he thought, and he was usually right

Schuerman and his lieutenants decided the best way to put together a staff for Arnall’s new

enterprise was to raid established consumer-finance companies They targeted Transamerica,

knowing its branch managers weren’t paid well and got a lot of abuse from higher-ups Long Beachidentified a group of branch managers who were willing to make the jump They agreed to resignfrom Transamerica en masse Arnall decided to celebrate He threw a dinner for the new hires a night

or so before the date appointed for the defections After he got some drinks into them, Arnall circledthe room, asking what each hireling’s goal would be for loan volume in his new post at Long Beach.The liquor had loosened their tongues, and several offered optimistic figures for what they couldproduce Each time somebody gave a number, though, Arnall scoffed “We can do twice that,” hesaid

On the agreed-upon day, only one of the bunch quit to join Long Beach The others changed theirminds Perhaps, Schuerman thought, Transamerica had caught wind of the jailbreak and persuadedthem to stay by offering raises and promotions Or maybe there was another reason: Arnall had scaredthem away They were used to the pressure to produce, but they’d never encountered anything likeRoland Arnall’s hunger for loan volume

No matter Long Beach kept working to tempt folks to leave Eventually the bank hired perhapsfifty employees away from Transamerica The math was simple Branch managers at Transamericawere making $35,000 to $40,000 a year Long Beach could pay them more than that to start and, givenits bonus structure, could give them a chance to eventually triple what they’d been making at their oldjobs Long Beach was so successful in its recruiting incursions that Transamerica’s lawyers began tosend threatening letters

The second-mortgage business took off It performed so well that the S&L ran out of cash to bankrollits home loans The nest egg created by customers’ savings deposits simply wasn’t big enough Therewas only one thing to do: go to Wall Street.

The solution to Long Beach’s problem was an investment banking innovation called

“securitization.” Mortgages could be pooled together, and then bonds, known as “mortgage-backedsecurities,” would be sold to investors The income stream from borrowers’ monthly payments

underpinned the bonds Investors paid cash up front to purchase the securities, which gave them theright to get back the money they had put up as well as healthy interest payments

For mortgage lenders, securitization provided a means for turning long-term mortgages into

quick profits Instead of having to wait around for homeowners to make their mortgage payments

month by month, year by year, lenders could immediately turn the loans into cash by selling the loansfor use in securities deals The rapid turnaround allowed lenders without much capital of their own tomake more loans and dramatically increase their volume of lending Before securitization, lendershad either held on to their loans, collecting the payments until the homeowners owned their housesfree and clear, or sold them one by one or in groups on the “secondary market” to investors, who tookover the right to collect on the loans This tended to limit the ability of lenders to increase their loanvolume They either had to entice customers to deposit savings in the bank to bankroll loans, or theyhad to go through the paperwork-heavy process of selling loans on the secondary market

The attraction for investors was twofold First, pooling thousands of loans into a

mortgage-backed securities deal provided a cushion against the impact of borrower defaults If some borrowersdidn’t pay, the income stream from other loans in the pool would cover the losses from the loans thathad gone bad Second, securitization decreased information costs for investors By pooling mortgagesand having ratings agencies affix a grade to the securities, investors could get a prediction of

expected returns without having to investigate whether each borrower or each lender was on the and-up

up-Mortgage-backed securities had first emerged in the 1970s, under the aegis of Ginnie Mae andFannie Mae, two government-sponsored enterprises created to increase homeownership Then

Salomon Brothers, the Wall Street firm immortalized in Michael Lewis’s Liar’s Poker, got into the

act It created the first private mortgage-backed securities deal in 1977, helping Bank of Americapool together a portion of its home mortgages In 1978, Salomon opened Wall Street’s first mortgagesecurities department In 1983, Salomon invented a new kind of mortgage-backed security that notonly bundled together mortgages but also sliced and diced them into “tranches” (French for “slice”)that carried varying levels of risk The riskier the slice, the greater return investors could expect, tocompensate them for the greater chance of borrower defaults and other factors that might prevent themfrom getting repaid with interest Tranches allowed investors to calibrate the level of risk and rewardthey wanted

By the late ’80s, a growing number of Wall Street firms were securitizing conventional

mortgages—those taken out as first mortgages by borrowers with good credit There was also a smallmarket for securities based on second mortgages, which generally went to borrowers who were

considered higher risks—the kind of loans that Long Beach Savings had begun making after the

conventional mortgage business had proven to be a disappointment

Long Beach did a small securitization with Drexel Burnham Lambert, the hard-charging

investment bank best known as home base for junk-bond king Michael Milken, but then moved itsbusiness to Greenwich Capital, an investment bank that had established a Wall Street beachhead in aleafy Connecticut suburb a train ride north of Manhattan Greenwich pooled Long Beach’s newly

minted second mortgages into a series of deals that helped the S&L keep its residential mortgagevolume on an upward arc.

Despite its burgeoning home-loan business, Long Beach was getting heat from regulators Itsassets included hundreds of millions in raw land and commercial real estate, the kinds of investmentsthat were causing big problems at other S&Ls Long Beach’s second-mortgage business wasn’t yet

big enough to balance its mix of assets To keep the feds happy, Long Beach needed more home

mortgages It achieved this by approaching another S&L, Orange County’s Guardian Savings andLoan, and suggesting a trade: some of Long Beach’s commercial loans in exchange for some of theresidential mortgages that Guardian had originated

At year’s end, 1987, Schuerman, Rank, and Dubrish headed over to Huntington Beach to take alook at the home loans that Guardian was offering to swap

2 Golden State

Guardian Savings and Loan was owned by Russ and Becky Jedinak By vocation, Russ was a

salesman, not a banker He had started his career as a pharmaceutical rep for American Home

Products, climbing to national sales manager by the age of twenty-three He soon shifted to real estateand began building homes and other projects around Orange County He was tall and handsome andcompeted in marathons He married and divorced four times He flew his own four-seater jet Helived in the Bahamas and sailed his yacht through the Panama Canal His fifth wife, Becky, becamehis bookkeeper and business partner Becky was the hands-on manager: tough, beautiful, vigilant overevery detail She kept Guardian running, with an eye on the bottom line He dreamed the dreams andmade the deals “He wanted to be the biggest, richest person in the world,” one former business

associate said “Russ was classic frat boy; teeth, grins, and handshakes,” another recalled “After thatyou ended up talking to Becky, who was very attractive but had the warmth of a porcupine.” She liked

to say, “I worry about the pennies, and the dollars take care of themselves.”

Like Roland Arnall, the Jedinaks started their S&L in the early ’80s in order to finance estate development plans That changed when they hired Jude Lopez, an experienced hand in the

real-Southern California lending business Lopez suggested they get into hard money, making first

mortgages that refinanced borrowers’ existing home loans But Lopez had a caution: they should

expect to foreclose on a significant number of borrowers, and end up with a large portfolio of “realestate owned” properties—homes the S&L would itself own once the borrowers could no longerkeep up with their payments “You’re going to end up with forty REO properties on your books,”Lopez told Russ Jedinak “These people have a habit of not paying their bills You’re basically

making a loan based on the value of the property alone.”

Russ knew real estate, so he asked: What would the LTVs be? LTV stood for “loan-to-value”ratio If you had a $65,000 mortgage on a $100,000 home, the LTV would be 65 percent

Lopez assured Russ they would never lend more than 70 percent of a home’s value, and the

average would be closer to 65 percent Russ could live with that If a borrower defaulted, there

would be enough equity in the home for Guardian to claw back its money Soon Russ was living bythis maxim: “If they have a house, if the owner has a pulse, we’ll give them a loan.”

Guardian sniffed out borrowers through independent brokers, who made the first contact withhomeowners, put together their loan applications, and steered them to the S&L Some brokers were sopleased with the generous fees they collected on the deals that they dropped other lenders and

funneled all of their clients to Guardian Lopez personally approved each loan He made sure theappraisals were accurate and the LTVs were low After the mortgages were made, Guardian

maintained a tough collections policy: if the borrower fell one month behind on payments, the lenderfiled for foreclosure “You have to be aggressive—put the hammer down early,” Lopez said “In thiskind of business, if you get three months behind it’s difficult to catch up.” One mortgage broker

recalled: “Russ had no problem taking back the property He was quite okay with that.” In its first fullyear, Guardian’s mortgage-lending program foreclosed on twenty-four properties The S&L was able

to sell the bunch for a $400,000 profit, Lopez said

One day in 1987, Guardian got a visit from Wall Street Russ had bought an apartment complex

in Galveston, Texas, and arranged with Michael Milken’s firm, Drexel Burnham Lambert, to sell

some bonds backed by the property Drexel specialized in “junk” bonds, unpredictable investments inwhich there was a high chance that the issuer would default Investors expected higher interest tocompensate them for taking on that additional risk When Drexel bankers came to Orange County todiscuss the apartment deal, Russ Jedinak introduced them to Lopez, who showed them the home loansGuardian was making The bankers, always on the lookout for ways to put their creative financingskills to use, told Jedinak and Lopez they could put together a mortgage-backed bond deal with

Guardian’s high-interest loans

Mark Schuerman and the other Long Beachers began sifting through loan files at Guardian’s

headquarters in December 1987, looking for home-loan deals they’d be willing to take as part of theresidential-mortgages-for-commercial-mortgages swap they’d arranged with Guardian After they’dlooked at perhaps a hundred files, something began to dawn on them: these were really good loans,with lots of profit built into the fees and interest rates and, through the magic of securitization, anefficient way of extracting that profit

It was a lightbulb moment “This is it,” Schuerman thought Booking first mortgages instead ofsecond mortgages was an important part of the equation First mortgages required little more time orcost to originate, but they produced much bigger loan volumes Why make $30,000 or $40,000 loanswhen you could be making loans for $200,000? Guardian targeted homeowners who had fixed-rate,finance-company loans with interest rates of 14 to 18 percent, and put them in adjustable-rate

mortgages with an initial six-month teaser of 11.5 percent Those loans could earn 5 or 6 percentagepoints over Treasury securities, the standard measuring stick for most investments Investors whobought bonds backed by Guardian’s loans were willing to take 1.5 points over Treasuries And

Guardian could take the rest, 4 or 5 points per loan Schuerman could see that a well-run lender couldmake three or four times the profits on these sorts of first mortgages than it could on second

mortgages

“That’s a lot of money, man,” Schuerman recalled “You do a one-hundred-million-dollar deal,you make five million dollars.” Plus, the millions rolled in year after year, as borrowers continued tomake payments on their mortgages Russ Jedinak had stumbled onto something new, a melding ofcreative home lending and Wall Street financing, the essence of the subprime mortgage business

“He’s the guy that started the business,” Schuerman said “He’s a footnote, but he’s the guy.”

It was such a good idea that Long Beach Savings did what any self-respecting competitor woulddo: it stole the idea for itself Schuerman, Rank, and Dubrish let Arnall know they had uncovered anew business model “Great,” Arnall said “Start tomorrow.”

Arnall wasn’t a deep thinker Schuerman was convinced Arnall never read a single piece ofpaper given to him He acted from his gut The result, in terms of dollars and cents, was a history ofmagnificent blunders and magnificent triumphs Trusting Schuerman and the other Long Beachers tomove into first mortgages was one of his brilliant calls From this moment, Arnall was set on the path

to build an empire If Russ Jedinak thought big, Arnall thought bigger, and he had the brains and guile

to make his aspirations a reality

In those days, nobody used the term “subprime.” Long Beach called its loans “B-firsts.” Thismade it clear they were first mortgages and distinguished them from “A-loans,” which were for

borrowers with good credit B-firsts were expensive, but they were cheaper than the loans peddled

by hard-money lenders Schuerman and his team saw the loans as the equivalent of a “fixer-upper”:homeowners who’d hit a financial bump could pay off their bills, improve their credit record, andthen, after a couple of years, refinance into a cheaper loan “These were good people who for somereason in their lives had had one or two bad falls,” Bob Labrador, the former Long Beach

executive, recalled “They had real jobs and you could document their income… Mark felt he did aservice to deserving people.”

Arnall mostly left Schuerman, Dubrish, and Rank alone to run the mortgage operations He worked inLos Angeles while Schuerman oversaw things down in Orange County Still, managers and workers

in the mortgage unit felt Arnall’s impatience, the boss’s hunger to grow “He never cared how you gotthe volume and where it came from and what you had to do to get it,” Dennis Rivelli, a former LongBeach manager, recalled “He could care less Just pump it out and move on.”

Rank ran the quality-control side of the business He instituted checks and balances to ensurebad loans didn’t get through Borrowers’ incomes had to be verified and property appraisals had to

be accurate Long Beach had a crack staff of review appraisers who rechecked appraisals as the

loans came in the door Arnall didn’t see the point “I don’t think we need all these appraisers,” hetold Schuerman

The internal quality-control watchdogs were caught between Arnall at the top and the sales forcebelow The salespeople were men and women who’d mostly learned the loan business at

Transamerica and other rough-and-ready consumer-finance shops The watchdogs fought a constantbattle to maintain standards, to rein in the aggressive instincts of the salespeople who made money bybooking as many loans as possible “You tell a consumer finance kind of group to get volume, they’llget volume,” Schuerman recalled The key was to encourage the salespeople to produce, but not to cutcorners by falsifying loan paperwork or putting borrowers into loans they couldn’t afford “I don’tcare about volume,” Rank told Rivelli “I can sleep at night if I can say I funded loans that made

sense.”

Each month, as the numbers grew bigger, Arnall threw a celebration to mark the new record.Then he’d tell Schuerman and the rest that the record was now their floor; they had to beat it the nextmonth Arnall never asked Schuerman to do anything that was wrong But Arnall, Schuerman decided,didn’t understand the “consumer finance code,” the idea that you had to calibrate your loan

originations by taking market conditions and loan performance into account There were periods

when it made sense to “throw out the rule book,” loosening lending guidelines and pumping up thevolume But you had to be prepared to dial things back, get more conservative, and cut back on

volume, as market conditions declined or loan defaults started ticking upward

Even if it could never meet Arnall’s uncompromising expectations, the mortgage unit did post someimpressive numbers, hitting $90 million a month in mortgage volume within its first three years of

making B-firsts Long Beach was especially good at wooing the mortgage brokers who brought in theloans It courted brokers with golf outings and coached them on the new push for B-loans Brokerswere used to the dowdy A-loans market, a cookie cutter business where the prices were uniform andborrowers either qualified or didn’t B-loans were more labor-intensive because the borrowers’credit histories tended to be messier Long Beach promised brokers they could make higher fees and,once they got the hang of it, turn the deals around quickly “We made those promises,” Labrador said.

“We lived up to those promises The brokers fell in love with us.”

Long Beach had another asset in its campaign to woo brokers: a platoon of women who worked

as wholesale loan reps They were smart, they worked hard, and they were, by all accounts, beautiful

—so gorgeous they became known as “The Killer B’s,” a squad of knockouts who flirted and cajoled,persuading goo-goo-eyed male brokers to put their clients into one of the various “B-loan” programsthat Long Beach offered for credit-challenged homeowners Long Beachers bragged their companyhad “good prices, good programs, and beautiful women.” “They could get into the door Every malebroker wanted to talk to them,” said James Gartland, who worked as a mortgage broker in OrangeCounty in the late ’80s “At the same time, they were disarming enough to talk to women.”

The women and men on Long Beach’s sales staff dressed well, partied hard, and drove

expensive cars They were the vanguard of a new mortgage industry The business was, at that

moment, being transformed from a slow-moving world of bean counters and sober middle managerswho got paid to tell borrowers “no” as often as they said “yes” to a domain of salesmen and dealmakers It was not a coincidence that the new mortgage culture grew up in Orange County, a landwhere “cowboy capitalists” and get-rich-quick schemers had long held sway

In the early hours of January 16, 1987, Duayne “Doc” Christensen died in a one-car crash on OrangeCounty’s Corona del Mar Freeway His Jaguar veered off the highway and slammed into an eight-foot-wide bridge pylon Family, friends, and famous well-wishers packed Christensen’s memorialservice Robert Goulet sang Christensen’s favorite song, “Send in the Clowns.” Televangelist RobertSchuller, who’d built Orange County’s acclaimed Crystal Cathedral, paid his respects A pastor fromSchuller’s ministry asked the mourners to withhold judgment of the deceased: “Forgive him for notbeing as much as we wanted him to be.”

Christensen’s death laid bare what authorities called one of the most audacious insider bankfraud schemes in memory Christensen and a companion, Janet Faye McKinzie, siphoned some $40million out of his S&L, Santa Ana’s North America Savings and Loan, through a series of elaborateruses involving faked documents and shell companies

Christensen’s death may not have been an accident Regulators were preparing for a governmenttakeover of his S&L, an event he certainly knew would lead to the exposure of his crimes Policefound no skid marks indicating he had braked, and the angle of the crash suggested the car had beensteered into the abutment rather than simply running off the road Some who knew Christensen, though,suspected he’d faked his death and was sitting in the sun sipping drinks on some tropical isle

A few months after Christensen slammed his car into the highway wall, an enterprising writer

for Forbes magazine traveled to Southern California and reported that the “American Riviera” of

coastal Orange County had surpassed Florida and the New York–New Jersey megalopolis as home to

the nation’s largest collection of boiler rooms Beehives of telephone salesmen worked out of officebuildings in Newport Beach and around John Wayne Airport, cold-calling unsuspecting marks andpersuading them to fork over money for illusory investments At least one hundred boiler rooms in thecounty flogged gold, platinum, and other precious metals Others peddled coins, gems, oil

partnerships, and artichoke ranches

Boiler-room telephone operations got their name because, in their early years, they saved on rentand hid from authorities by tucking themselves in basements and boiler rooms The designation stuckbecause the idea of heat is central to boiler-room culture—a telephone operation was said to run at

“full burn” when every phone station was manned by a salesman, and they generated “heat” when thesalesmen were doing their jobs with urgency, working the phones and riffing effectively on their

scripted sales pitch “It’s a numbers game,” one longtime boiler-room salesman explained “Makeenough calls, and you sooner or later get the deals.” It was the same spirit that a generation later

would infuse the mortgage boiler rooms run by Orange County’s subprime lenders

In the spring of 1987, five dozen local and federal cops raided three closely tied boiler rooms inOrange County that authorities alleged were selling bogus investments in gold and other preciousmetals under the names World Equity Mint, Associated Miners Group, and Liberty Mint and MintManagement An informant identified in court papers only as “George Washington” said the

companies pulled in up to one hundred thousand dollars a week Half went to operating expenses, theinformant said, and the rest went to supporting the owner’s extravagant lifestyle as well as to buildingthe stash “he hides in anticipation of police investigation.”

As Ronald Reagan’s second term neared its end, Orange County had established itself as a

hotbed not only for boiler rooms and S&L shell games, but for real-estate swindles and mail fraud aswell U.S postal inspectors called the county “the fraud capital of the world.” Near the height of the

S&L crisis, Orange County Register columnist Jonathan Lansner observed that his newspaper was

publishing articles about local business fraud “at a pace of just under one a day.” “Some days,” hesaid, “it seems that more Orange County business deals are discussed in court rooms than in boardrooms.” One local private detective who specialized in investigating shady real-estate contracts told

Forbes: “I’ve worked cases where the lender loaned money to people who didn’t exist, who bought

houses from people who didn’t exist, whose documents were notarized by people who didn’t exist Inone case there were only two true facts: There was a house and a savings account The savings

account had 40 signers and only one was a real person.”

It wasn’t hard to understand why Orange County had become fertile ground for boiler rooms and other

white-collar misconduct Long before TV shows such as The OC and The Real Housewives of

Orange County introduced Middle America to the region’s exotic mélange of beaches, mega-malls,

and bustling plastic surgery practices, Orange County embodied the high life It was sunny and

manicured—scrubbed clean of the kind of gray film that covers many urban areas in the Midwest andNortheast “You don’t hear much about unusual concentrations of fraud in Green Bay or Buffalo,”

Wall Street Journal writer Hal Lancaster noted in an essay on the county’s mixture of glitz and snake

oil “Con men hate snow.” Besides, if you’ve had some legal scrapes back east, it’s easier to beginanew in a fast-growing place where many people are strangers to each other and, in absence of a

tradition of “old money,” nobody asks where your wealth comes from, no matter how much you flaunt

it Lancaster visited Newport Beach’s swanky Fashion Island Shopping Center in the late ’80s,

eyeballing the seaside community’s “tanned and elegant ladies” as they stepped out of their

Mercedes-Benzes and BMWs and inspected the designer offerings at Neiman Marcus and BullocksWilshire “In the squat office buildings that ring Fashion Island,” he noted, “the odds are good thatsomeone is getting fleeced Law-enforcement authorities say that at any given time, a host of

fraudulent telemarketing operations mingle with the many legitimate businesses here.” As one postalinspector told Lancaster: “They seem to like these industrial parks We call them fraud farms.”

People with an expansive definition of free enterprise found a welcoming home in Orange

County The county had grown from barely 130,000 souls at the start of World War II to a population

of more than two million in the ’80s It was, as one scholar put it, “a modern-day version of the

California gold rush—making Orange County the new frontier West of the second half of the twentiethcentury.” The rush was led by a tight group of ranchers-turned-developers, real-estate speculators,and prosperity-gospel evangelists who championed individual uplift and disdained government

interference in the marketplace Given the county’s history and culture, it’s no wonder that more than

a few locals came to the conclusion that a bit of entrepreneurial derring-do wasn’t a bad thing “Many

of these people got too much power and money too soon,” one Newport Beach psychotherapist told

Forbes “Their moral and ethical codes haven’t caught up.”

That was a description that could certainly fit Doc Christensen The son of Seventh-Day

Adventists, Christensen considered a career as a minister, but instead became a dentist After a while,his interest in dentistry waned; he spent much of his time thinking up ways to make money He began

to offer investing seminars to physicians He opened a mortgage company, and soon he was the target

of lawsuits accusing him of mortgage fraud That didn’t prevent him from getting a license to operate

an S&L, however He had pulled together a few million dollars to capitalize the venture and brought

in an experienced banker to serve as the front man That was enough to satisfy the regulators, whoissued Christensen a license to open North America Savings in 1982

He met Janet McKinzie a year later Both of their marriages were rocky He was wealthy,

educated, and handsome, a fit six-footer “with a lopsided grin that made him look much younger thanhis fifty-three years.” She was thirty-three, slender, with “almost white, baby fine hair.” She had

grown up in poverty and was determined never to be poor again She was a hard-driving real-estateagent who was so high strung, one friend recalled, that she carried a big jar of Excedrin, popping thepain reliever constantly Christensen tried to help her relax by prescribing her a hodgepodge of

powerful antianxiety drugs, including Xanax, Halcion, and lithium

Christensen hired McKinzie as a “consultant,” and over the next four years the two turned theS&L into their personal cash box

McKinzie flew back and forth between Southern and Northern California on a Lear jet paid for

by North America Savings She spent money with lavish obsession, blowing $750,000 on shoppingsprees at the Neiman Marcus in Newport Beach Her $165,000 Rolls-Royce Corniche sported thepersonalized license plate “XTACI.”

Christensen and McKinzie milked the S&L by plowing its money into a variety of deals in whichthey had hidden interests, in one instance, authorities alleged, designating McKinzie’s hair dresser asthe president of one of the front companies they controlled In another instance, North America

Savings paid less than $4 million for a condo project in Lake Tahoe, Nevada, then sold it back andforth between the S&L and front companies to artificially inflate its value to $40 million

Not long before his car wreck, Christensen took out a $10 million insurance policy and made

McKinzie the beneficiary It was little comfort for McKinzie With Christensen dead, she was left totake the rap When her case came to trial, the best her attorney, Richard “Race horse” Haynes, could

do for a defense was to claim she was too strung out on prescription drugs to pull off such an

elaborate swindle Haynes said Christensen used the pills to control McKinzie, turning her into a

“washed-out zombie.” This defense was undermined by evidence that McKinzie had orchestrated acover-up She ended one note coaching a business associate how to lie to investigators with the

instruction, “P.S Please destroy after reading.” A judge sentenced her to twenty years in prison Shewas one of more than a thousand S&L insiders nationwide convicted of felonies

In the midst of the S&L crisis, U.S attorney general Richard Thornburgh wondered whether the

debacle might be “the biggest white-collar crime swindle in the history of our nation.” Thornburgh,who had gained a reputation as a corporate crime fighter when he was a prosecutor in Pittsburgh, hadbeen appointed to run the Justice Department to help improve the image of the scandal-prone Reaganadministration He stayed on under the new president, George H W Bush, and vowed to punish theexecutives whose crimes had helped destroy the S&L industry Thornburgh focused a large part of hisagency’s investigative muscle on the seven-county region of Southern California dominated by

Orange and Los Angeles counties During a congressional hearing, he explained that no less than 76percent of the 21,714 allegations of insider abuse at S&Ls that had been reported to his departmentcame from the region In Orange County alone, twenty-seven S&Ls failed, at a cost of more than $10billion to taxpayers, more than twice the amount that had been set aside in the insurance fund that wassupposed to cover S&L failures across the entire United States, and a lopsided share, for a singlecounty, of the $124 billion that American taxpayers eventually shelled out to clean up the S&L messnationwide

One street corner in Irvine, in the heart of Orange County, accounted for $8.4 billion of the

losses Charles Keating’s Lincoln Savings and Loan and Charles Knapp’s American Savings andLoan were headquartered across the street from each other at Von Karman Avenue and MichelsonDrive Lincoln’s failure cost taxpayers $2.66 billion The collapse of American Savings cost $5.75billion, more than any other thrift failure

Both Keating and Knapp went to jail for S&L-related felonies, but it was Keating who, with alittle help from Wall Street, became the poster boy for S&L criminality Keating had been a championswimmer and navy fighter pilot As a lawyer and businessman in Cincinnati, he had won fame as anantiporn crusader He charged that communists were using smut and immorality to undermine

America In one of his many public appearances, he told an auditorium of high school girls the story

of a young mother who was hit by a car while she pushed a baby carriage across the street The

woman, Keating explained, had been wearing Bermuda shorts, and the driver had been distracted byher bare legs He implored the girls to sign a pledge not to wear Bermuda shorts

President Reagan considered appointing Keating as his ambassador to the Bahamas, but the

nomination was sidetracked when it came out that the Securities and Exchange Commission had

slapped Keating with an injunction in 1979 for using his position at an Ohio bank to arrange for

millions of dollars in sweetheart loans to insiders and cronies Securities cops alleged that one of theinsiders was Keating himself The government charged, too, that Keating and others had used “fraud

and deceit” to sell dicey securities to investors He settled the charges by agreeing not to violate

securities laws again

He moved his base to Arizona, where he took over a failing home-building concern, AmericanContinental Corporation, or ACC He had bigger ambitions and wanted to buy an S&L to supportthem, but he didn’t have the necessary cash He turned to junk-bond king Michael Milken, who had set

up a West Coast outpost of the Wall Street investment house Drexel Burnham Lambert Milken

arranged the financing for Keating’s $51 million purchase of Orange County–based Lincoln Savingsand Loan Keating didn’t have to put up any of his own money

Just as Keating needed Milken, Milken needed Keating Milken had created a huge market forjunk—risky bonds issued by financially weak companies that want to borrow money—by sellinginvestors on the idea that they weren’t as chancy as the name implied Milken was looking for placeswhere he could off-load the worst junk and “restructure” bonds on the verge of default, obscuringtheir true default rates and artificially inflating their values Lincoln Savings, federal regulators

charged, would become one of a dozen “captive” S&Ls, a daisy chain of thrifts willing to issue andbuy Milken’s junk bonds and swap them back and forth among themselves The S&Ls, the regulatorsalleged, let Milken buy junk bonds in their names; at the end of each day they were informed whichjunk bonds they had purchased He was, financial writer Ben Stein would say, “sucking the blood ofcaptive S&Ls like a vampire.”

After Keating took control of Lincoln in early 1984, he suspended the thrift’s home-loan programand began plowing its funds into multimillion-dollar commercial projects, along with nearly $3

billion of Milken’s junk bonds Lincoln employed many of the fast-and-loose practices Keating hadbeen accused of in Cincinnati on a wider scale in Orange County Auditors found the S&L had

recorded millions in sham profits on real-estate deals that were little more than accounting

gimmickry

As financial pressures and regulatory battles mounted, Keating kept Lincoln alive by selling

“subordinated debentures”—$250 million in junk bonds issued by ACC, the S&L’s parent company.The bond investors, twenty-three thousand in all, weren’t sophisticated Most were elderly Manywere longtime Lincoln customers who’d come into branch offices around Orange County to roll overcertificates of deposit that were expiring CDs were safe and government-insured; the junk bondswere backed only by the faith and credit of ACC Later, Keating admitted to one federal regulator thatACC and Lincoln were continuing to sell junk bonds and present themselves as secure and sound at atime when Lincoln was staring down a $2 billion loss

Much like the young salesmen who would peddle mortgages for Orange County’s subprime

lenders two decades later, Lincoln’s junk-bond salesmen were egged on by managers who promisedperks and bonuses and demanded they sell with single-minded tenacity At one meeting of Lincolnsales staffers, a top executive dressed up as a cowboy and gave his young charges this advice: “Whenyou get a customer, be sure to sell them a bond If they say no, offer them a bond And if they still arenot interested, try to sell them a bond.” Inside Lincoln’s branches, workers wore T-shirts that read

“Bondzai” and “Bond for Glory.” Salesmen told customers the bonds were “comparable to a CD.” Ifcustomers asked if they were buying a “junk bond,” the salesmen replied that the term was

misleading What they were really getting were “young bonds.” A memo written in Phoenix by ACCexecutives ended with this admonition: “And always remember the weak, meek and ignorant are

always good targets.”

Many lost their life savings when Lincoln went under in 1989 They were people like AnthonyElliott, an eighty-nine-year-old widower from Burbank He lost perhaps $200,000 On Thanksgiving

Day 1990, he sat down and typed a suicide note: “There is nothing left for me of things that used to

be My government is supposed to serve and protect, but who? Those who can gather the most savingsfrom retired people.” Three days later, a Sunday, he climbed into his bathtub and slit his wrists andforearms with a straight razor He was dead when his part-time housekeeper found him the next day

As the scheme began to unravel, Keating fended off regulators by doing what he’d always done:threatening his enemies and calling on his friends He intimidated the regulators by filing lawsuitsaccusing them of “a pattern of harassment and misrepresentation.” He hired private detectives to

snoop on William K Black, the litigation director for the Federal Home Loan Bank Board At onepoint, Keating’s lawyers claimed he was a victim of a secret homosexual conspiracy hatched in

federal thrift regulators’ San Francisco offices

Keating traded on the clout of five U.S senators who’d shared roughly $1.3 million in campaigncontributions from him Among them was a newly elected senator from Arizona, John McCain Asformer navy fliers, Keating and McCain had become close, with Keating treating McCain and hisfamily to free plane rides and vacations at Keating’s hideaway in the Bahamas The senators, whowould become known as the “Keating Five,” championed Keating’s cause with the regulators whowere trying to slow him down

Keating also enlisted the help of Alan Greenspan, onetime chairman of President Ford’s Council

of Economic Advisers Greenspan was now working as a private consultant As a young economist,

he had been a disciple of Ayn Rand, the charismatic proselytizer of free market beliefs In 1963, hehad written an essay for Rand’s journal arguing, “it is precisely the ‘greed’ of the businessman…which is the excelled protector of the consumer.” Regulation of business practices, Greenspan said,was unnecessary “What collectivists refuse to recognize is that it is in the self-interest of every

businessman to have a reputation for honest dealings and a quality product.” He said a company

couldn’t afford to risk the years it had spent building up its reputation “by letting down its standardsfor one moment or for one inferior product; nor would it be tempted by any potential ‘quick killing.’”

If Keating needed someone to help him get the regulators off his back, Greenspan was his man

As Keating’s hired gun, Greenspan wrote a letter to regulators pronouncing Lincoln’s

management as “seasoned and expert” and concluding that the S&L was “a financially strong

institution that presents no foreseeable risk” to the Federal Deposit Insurance Fund By the time

Greenspan’s miscalculations were exposed he was already serving as chairman of the Federal

Reserve, the government entity chiefly responsible for overseeing the banking system “When I firstmet the people from Lincoln, they struck me as reasonable, sensible people who knew what they were

doing,” Greenspan told the New York Times “I don’t want to say I am distressed, but the truth is I

really am I am thoroughly surprised by what has happened to Lincoln.” It would not be the last timeGreenspan was forced to admit a mistake in judgment

Roland Arnall’s Long Beach Savings avoided the fate of Lincoln Savings and other S&Ls in largepart because of the profits it was posting from its subprime mortgages during the late ’80s and early

’90s As its subprime unit cranked up, Long Beach’s profits exploded, growing from $2.8 million in

1988 to $14.1 million in 1989 Regulators might not have liked Arnall’s big real-estate deals or LongBeach’s brand of risky home loans, but they couldn’t argue the thrift wasn’t serving the mission of

S&Ls—to make home loans—or that it didn’t have the money to shield it from losses in commercialreal estate Long Beach was successful because, at the behest of regulators, it was doing the opposite

of what Alan Greenspan—and other fans of deregulation—had recommended for S&Ls Greenspanhad advised that S&Ls should diversify their risks by increasing their investments in quick-buck

commercial real-estate deals and reduce their dependence on long-term home loans Long Beach wasmoving away from commercial investments and focusing itself, more and more, on residential

lending

Long Beach also survived because Arnall was, by nature, a suspicious man He hated the idea ofanyone getting the best of him in a business deal That’s why, unlike other S&L operators, he resistedthe blandishments of Michael Milken Milken had tried to make a move on Long Beach, to get thethrift to join Lincoln Savings and the other captive S&Ls that helped keep his junk bond scheme

flying Bob Labrador, Long Beach’s treasurer in those days, heard Milken speak in the mid-1980s at adinner in Los Angeles for banking professionals Labrador was persuaded by Milken’s argument thatmarkets were under-valuing his junk bonds, creating an opening for investors who were savvy enough

to snap up the cheap assets The S&Ls that were doing well investing in Milken’s junk included

Beverly Hills’ Columbia Savings and Loan With Milken’s help, the S&L gobbled up more than $4billion in junk bonds and became, on paper, the nation’s most profitable S&L

Labrador could see the riches Columbia was producing through the fortunes of a friend whohappened to be Columbia’s vice president of finance Labrador’s pal drove around in a new

Mercedes Sometimes he and Labrador vacationed at Utah’s Deer Valley Resort, in condos owned byColumbia Columbia’s conspicuous success helped sway Labrador to the idea that Long Beach shouldconsider investing in junk bonds, too “I thought they were a way I could make a name for myself Icould be a hero,” Labrador recalled wryly

Arnall considered the idea But he decided to steer away from Milken and his investments Henever said why—he often kept his reasons to himself Looking back, Labrador wondered if it was a

takes-one-to-know-one shrewdness: “He may have seen himself in Milken: He’s just like me; he’s going to sell everybody on this and when it blows up, he’s gone.” Labrador thought it was a bit like

Arnall’s decision not to get into franchising car washes Arnall never wanted to put himself in a spotwhere a business partner was in control He wanted to be the one with the upper hand

3 Purge

In the summer of 1990, Greenwich Capital put together a $70 million mortgage-backed securities dealfor Roland Arnall’s S&L It was the first time Long Beach had “publicly placed” securities backed bysubprime mortgages, meaning that the transaction was filed with the Securities and Exchange

Commission and Greenwich was able to peddle the assets to a wider array of investors than wouldhave been possible under a “privately placed” deal With Greenwich securitizing many of Long

Beach’s loans, the S&L didn’t have to worry as much about drawing in customer deposits to fund itsmortgage operations Gaining access to the nation’s capital markets changed the tenor and scale ofLong Beach’s business “It was a significant transitional moment,” Bob Labrador, Long Beach’s

treasurer, said “You had to keep pumping out more and more loans to feed the Wall Street machine.”Arnall maintained a hectic pace as his empire grew He lived on the phone, making deals,

seeking inside information, and trying to shake loose more money from financial backers In the ’80s,

he had one of the earliest car phones installed in his Jaguar, running up bills of $10,000 to $15,000 amonth as he cruised around Southern California He eventually stopped driving himself and hired achauffeur One story had it that he was forced to stop driving after he’d rung up too many tickets forrunning red lights while gabbing on the phone and for double-parking because he didn’t want to wastevaluable time searching for a space

He expected his subordinates to match his pace and his drive Sometimes he exercised his

authority by yelling and blustering More often he used the silent treatment When a trusted adviserfell out of favor, Arnall began to refer to him as “what’s his name.” Arnall believed he was simplyenforcing accountability within his organization “He was demanding But if you did what you saidyou were going to do, your life was fine,” one longtime employee recalled Some thought his

management style was dictatorial “With Roland, it was always a search for the guilty,” a formerLong Beach manager said Once, a young switchboard operator who didn’t realize that it was the bosscalling in made a faux pas Arnall was impatient to be connected to an assistant immediately, and he

let the young phone operator know it “All I can say is just chill,” the operator replied The young

man was gone the next day In another episode, Arnall was giving a tour of his headquarters to a

group of financial backers, a task he enjoyed As he was extolling the virtues of his S&L, a fax

machine screeched and spewed out an offensive, hand-drawn cartoon: a crude, larger-than-life

rendering of a penis Arnall was livid He promised heads would roll, demanding that his aides huntdown and punish the prankster The matter was dropped, a former Long Beach executive said, when itwas established that the fax had come from the offices of one of Long Beach’s biggest-producingmortgage brokers

Arnall kept his top executives in their places by withholding their year-end bonuses until wellinto the next year, sometimes for months That extra period allowed more opportunities for mistakes

or missed loan-production goals, which he could use as an excuse for shaving a bit off their checks

“He would say: If it hadn’t been for that thing in May, it would have been bigger,” a former employeerecalled He also kept them on their toes by assaulting them with a succession of proposals for

improving the S&L’s efficiency and profits He might have read something in a business managementbook, or met someone on a plane or at a party who might be, as a former employee put it, “in the

ladies’ undergarment business.” The new idea or new business contact would become Arnall’s latest

preoccupation He might hire his golden boy to come work at Long Beach, or decide that someonealready working for him was an undervalued talent This favored employee would enjoy a

honeymoon in which he or she could do no wrong “He was an idol worshipper,” one former businessassociate noted But almost as quickly as Arnall could fall in love with an employee, he could fall out

of love, too The once-invaluable employee would be demoted to “what’s-his-name” status

One senior manager thought the way to stay in Arnall’s good graces was to cut corners to get thejob done “The only way you could survive and excel was to cheat,” the former executive said

“Those who cheated were rewarded Those who did the right thing were treated as second class.”One area in which Long Beach cheated was in feeding inaccurate information to federal regulators.The regulators required Long Beach to submit a detailed business plan The S&L had to project itsloan volume and then hew to its projections—with the trend lines neither too far below projectionsnor too far above But the subprime lending program was doing well enough by the early ’90s thatloan volume was growing faster than expected Long Beach fudged its books, shoving loans it hadmade in one month into the next to hide the true level of growth According to the former executive,Arnall was aware this was being done

Russ and Becky Jedinak weren’t as adept as Roland Arnall when it came to escaping the S&L

industry’s problems After making money for years, their S&L, Guardian, had fallen on hard times,losing almost $5 million over 1989 and 1990, in part because regulators had forced them to changethe thrift’s accounting practices to set aside more cash for covering bad loans

At the same time, Guardian was drawing attention for the kinds of loans it was making to

vulnerable homeowners “What we’re seeing is people with little expectation of being able to repay aloan are being lent money—especially elderly black people,” the litigation director for Bet Tzedek

Legal services, a law clinic for the impoverished and unlucky, told the Orange County Register.

Eventually, as California’s real-estate market fell in the early 1990s, some pools of Guardian’s

adjustable-rate loans would suffer delinquency rates of 23 to 51 percent

Examiners with the federal Office of Thrift Supervision concluded that Guardian had gouged andmisled its borrowers Top Guardian officers also approved loans with false or unverified

documentation, according to the OTS The agency also charged that the S&L had misled the

government, trying to hide its dicey practices by removing or “losing” boxes of records “Guardianhas…violated laws and regulations” and “is vulnerable to acts of fraud,” the agency said One casecited by the OTS involved Odessa Howell, a seventy-five-year-old widow who was battling cancer.She signed for two loans from Guardian totaling more than $300,000 She was supposed to get somemoney to pay for home improvements, but a large slice of the loan proceeds was diverted into feesand other charges, including more than $100,000 that went into a mortgage broker’s pocket Howellsaid she didn’t have “the faintest idea” what happened to the cash The OTS noted the deal was puttogether with falsified paperwork that bestowed the elderly borrower with a make-believe job at amake-believe company “The stated source of repayment for the loans was based upon a financialstatement for a business that neither exists nor with which Ms Howell is affiliated.”

Russ Jedinak countered that the government was flat-out wrong “The fact is we’ve never hadany financial losses due to fraud, or financial losses due to the funding of our single-family home

loans,” he said But the government had a stranglehold on Guardian In early 1991, Russ agreed toresign as chairman, and Becky agreed to resign as senior executive vice president Russ, the S&Lsaid, would “pursue other interests.” Russ’s defenders thought he mainly had erred by antagonizingregulators rather than trying to smooth things over with them “He’s a high-powered salesman,” JudeLopez, the Jedinaks’ former aide, said “He doesn’t understand diplomacy He thinks if you makemoney everything is all right.”

Ultimately, the government determined that the Jedinaks had used Guardian as a piggy bank,siphoning off money for themselves with sweetheart loans and using S&L funds to pay for personaltravel and other non-business expenses It also said the Jedinaks mishandled major commercial

investments and caused the S&L to misreport its financial condition

Even without the Jedinaks’ involvement in the day-to-day management of the thrift, the

government concluded that Guardian was a lost cause Regulators seized the S&L in June 1991,

making it the twenty-third thrift it had taken over in Orange County since the crisis began The finalstraw had been the decision to write down the value of Guardian Center, the company’s gleamingheadquarters on Beach Boulevard in Huntington Beach The Jedinaks had paid $55 million for it in1988; now it was worth less than half that The write-down left Guardian’s financial condition soprecarious that the OTS believed it had no choice but to put the S&L into government receivership

Over at Long Beach Savings, things were going better, so well in fact that Arnall closed the mainoffice in the company’s namesake city and moved the headquarters to Orange County, into the high-rise on Town and Country Road that had long been home to the S&L’s subprime lending operations Itmade sense, now that subprime was Long Beach’s main line of business Arnall relocated there, too,knocking down walls and turning three offices into an expansive executive suite, complete with aprivate kitchen, for himself He also adopted a new name for the company: Long Beach Savings

morphed into Long Beach Bank, FSB, as in “federal savings bank.” Many thrift s were renamingthemselves in just this way, in an effort to distance themselves from the taint of the S&L scandal

Arnall’s greater physical presence signaled his determination to put his own imprint on the

mortgage unit He brought in a coterie of management consultants Workers arrived one Monday tofind that, over the weekend, the entire headquarters on Town and Country Road had been taken apartand put back together Cubicles had been rearranged and employees were informed that they werebeing shifted into different jobs The idea behind the reorganization was to make the loan operationrun with the speed of an assembly line If Long Beach could already move a loan from application toapproval in forty-eight or seventy-two hours, the thinking went, couldn’t a more streamlined processproduce a same-day “turn time”—taking a submission from a mortgage broker in the morning andcoming back with a yes or no by the end of the day?

The reorganization was a disaster Turn times got worse, not better, with it sometimes takingfour days to convey the decision back to the broker “They took something that really wasn’t brokenand broke it,” one longtime employee said The problem was that many Long Beach employees hadbeen shuffled into jobs they weren’t familiar with, and, the truth was, examining loan applicationsrequired that real people exercise real judgment It wasn’t a process that could be modeled on anassembly line In the subprime world, each borrower’s story was different People had credit

problems, interruptions in their job histories, or other complicating issues Borrowers needed holding, and their applications needed scrutiny to ensure their loans made sense After Arnall

hand-scrapped the existing systems in favor of the consultants’ new efficiency theories, Long Beach’s loanvolume plummeted from $90 million to $30 million a month

When some managers objected to the changes, the consultants made it clear they were in charge:The train had left the station, and either you were on it or you were off The arrival of a gang of

consultants often doesn’t bode well for managers who represent a company’s past, even if that pasthas been successful It eventually dawned on Schuerman that Arnall was using the consultants to

engineer a “nonviolent coup” in the mortgage division Now that Arnall was settled into the OrangeCounty offices and focusing on subprime, he was determined to make some personnel changes Hewanted to get rid of the top aides who had built the business that had kept Long Beach afloat duringthe S&L crisis “Once it was working well, Roland wanted it all for himself,” one former Long Beachexecutive recalled Arnall fired Rank, the S&L’s quality-control guru, as well as Rank’s top aide inoperations, Dennis Rivelli Schuerman lingered for a few more months At staff meetings, Arnallbrushed aside his input Then Arnall started holding key meetings without him Schuerman thought itcame down to a “control thing He had the illusion I was trying to be more important than the

company.” All classic entrepreneurs, in Schuerman’s view, were driven by a strain of paranoia; whenyou’re trying to build an empire and taking on the world, you tend to eye people with suspicion, asimpediments to your ambition to gain more power and more success

Schuerman didn’t like getting pushed out, but he wasn’t the sort to hold grudges He joked withArnall about it: if Arnall really wanted to get rid of him, Schuerman said, Arnall could have saved thecompany money by forgoing the outside experts and simply giving Schuerman half of what he’d spent

on consulting fees Arnall put a good face on the split He threw Schuerman a going-away party,

inviting some of Long Beach’s allies on Wall Street to come out to the West Coast to see Schuermanoff

Schuerman was set to receive a substantial sum on his exit since, under his original agreementwith Arnall, he had been given a stake in the business Schuerman recalled that Arnall paid him somemoney to go away It wasn’t as much as Schuerman, who had helped build the mortgage division fromscratch, thought he was due But knowing Arnall’s reluctance to pay people what he owed them,

Schuerman felt lucky to get anything out of him “He fucked me,” Schuerman said “But within

reason…within tolerance levels.”

In the fall of 1992, Russ and Becky Jedinak made an appearance at the Mortgage Bankers

Association’s national convention in San Francisco An old business associate, on his way to a

cocktail party at the St Francis Hotel, ran into the couple on an elevator Becky, he recalled, waswearing a blue dress Russ had on a $1,000 suit On his breast pocket, Russ wore a name tag issuedfor conference attendees by the trade association He’d crossed out “Guardian Savings” and written,

by hand, “Quality Mortgage.”

The Jedinaks were back in business, little more than a year after regulators had shut down theirS&L Their new venture, Quality Mortgage USA, was an independent mortgage lender rather than abank or S&L This absolved the Jedinaks from having to obtain a license from state or federal

regulators The couple controlled Quality through a holding company, and in some states conductedbusiness through affiliates sporting other names, such as Express Funding With federal authoritiesstill investigating the Jedinaks’ role in Guardian’s collapse, it seemed best to build a bit of legalinsulation into the corporate structure Still, Quality Mortgage was essentially the same company asGuardian, with many of the same employees and many of the same independent brokers feeding loansinto the Jedinaks’ subprime fiefdom.

The Jedinaks’ problems at Guardian didn’t dissuade Wall Street from assisting the couple intheir new start They got help from Donaldson, Lufkin & Jenrette, an investment bank that was

expanding its reach after hiring many of Michael Milken’s former underlings from the wreckage ofDrexel Burnham Lambert’s Beverly Hills offices DLJ took a 49 percent stake in Quality Mortgageand helped bankroll the company’s loans and package them into mortgage-backed securities Qualitywas, according to one top DLJ executive, “the first subprime/Wall Street joint venture”—the firsttime a player on Wall Street had taken an ownership stake in a subprime lender

Quality was aggressive about pushing loan products that made it easier for borrowers to qualify.These included “Quick Qualifier” loans and “stated income” loans that didn’t require documentation

of borrowers’ wages—the sort of loans that someday would become ubiquitous but were not commonduring the 1990s

DLJ’s financial support allowed Quality to ramp up quickly and spread across California andthen the rest of the nation Russ Jedinak hired staff in bunches and pushed for leapfrog expansion intonew markets, making do with whatever quarters he could find James Gartland, a mortgage broker inOrange County in the early ’90s, stopped by a Quality office one day to talk to the wholesale rep whowas his contact at the lender Fishnets and starfish hung on the walls A fax machine sat on the bar.Gartland’s wholesale rep was working at a table inside a red upholstered booth The space had

previously been occupied by a seafood restaurant, and there wasn’t time to waste on redecorating.Jedinak traveled far and wide, usually behind the controls of his jet, a four-seat Cessna Citation

He rented hotel ballrooms and invited brokers to attend his road shows—and to bring their latest loanfiles with them He gave away Sony Walkmans and other prizes, offering the brokers an extra half-point commission if they would march to the back of the room and submit their customers’

applications on the spot to Quality’s loan underwriters As Jedinak flew his jet across the country, hesometimes looked down and saw the lights of a city he’d never visited in his life…and decided that

he had to open a branch there.

When he gathered his sales force together, he let them know the sky was the limit, for them andfor Quality Mortgage At company meetings, top-producing loan reps won time inside a money

machine, a booth that blew a tornado of cash around Whatever bills they could grab and stuff in theirpockets, they got to keep At one event, Jedinak illustrated the fierceness of Quality’s salesmanshipand competitive instincts by strutting into the room with a full-grown lion on a leash At another hehad armed security guards march in with bags of money and dump the cash into a big pile Then hestood on the pile, announced he was standing on a million bucks, and gave a speech about how muchmoney his sales reps could make if they worked hard and dreamed big

Just as Long Beach Savings had competed with Guardian, now Long Beach Bank, FSB, found itself

competing with Quality They were bitter rivals The Jedinaks’ company was more willing to take onrisky borrowers, and to offer creative loan products and cut prices to make a deal happen “Anythingaggressive, Quality was doing it first,” recalled Adam Levine, an account manager at Long Beach inthat era “Quality pushed Long Beach pretty hard We had to respond.” If Quality came up with a loanproduct with a 3.99 percent initial “teaser rate,” Long Beach had to at least come within shoutingdistance, rolling out a loan with a 4.99 percent teaser Long Beachers thought of Quality Mortgageand Long Beach as “the evil twin and the good twin,” Levine said Long Beach’s loan reps

considered themselves to be more professional They were required to wear ties They were

encouraged to think of themselves as bankers, and viewed Quality’s reps in the field as equivalent tocar salesmen Folks at Quality dismissed Long Beachers as corporate types, with their button-downbusiness attire and written policy manuals “Long Beach was more particular than we were,” saidJude Lopez, who joined the Jedinaks at their new venture “They really couldn’t compete with us.”

With their company’s more aggressive style, Quality’s field reps often stole deals from LongBeach by undercutting Long Beach’s prices “They used to follow us around, sometimes figuratively,sometimes literally,” Levine said He realized his competition from Quality would ask brokers aboutloans that Long Beach had already approved—and offer a better price for the same loan on the spot,without underwriting it, because the Quality rep knew Long Beach had already checked the

borrower’s qualifications

Some Quality employees were creative about handling the headaches that came from borrowers

with less-than-impressive credentials One manager told the Orange County Register that a top

Quality executive disguised the company’s loan delinquency rate with accounting legerdemain,

shifting money from loan accounts that were current and applying the money to accounts that weredelinquent, then later switching the money back to the right place The Jedinaks saw those kinds ofactions as “signs of initiative and loyalty,” the manager said

Quality’s freewheeling ways also left it open to legal attacks from unhappy borrowers The

Jedinaks found themselves fighting off dozens of lawsuits, spending $2 million a year in lawyers’fees The allegations were similar to complaints that had been aimed at their previous company,

Guardian The lawsuits claimed Quality socked customers with unfair fees and misled them abouttheir loan terms A class-action suit in Alabama charged that Quality “corrupted hundreds of smallmortgage brokers by offering them—and paying them—illicit commercial bribes” to betray

borrowers who thought the brokers would get them the best rates they qualified for Quality’s hiddencommissions compromised the brokers, encouraging them to steer these customers into loans with

“artificially inflated” interest rates, the suit claimed In a case in Hawaii, a borrower accused twoQuality affiliates of “manipulation and deception” as part of a “continuous cycle of unlawful

predatory practices.” Her first loan through a Quality affiliate had a starting rate of 8.9 percent Butthe adjustable rate soon climbed past 11 percent Her payment rose from $1,674 to $2,016 a month.Mortgage rates in the marketplace were beginning to come down, so she called and asked if she couldrefinance into a lower, fixed rate According to her court claims, Quality’s affiliate promised shecould get a lower rate, and get some extra money for Christmas and to renovate her home Instead, shesaid, the interest rate on the new loan turned out to be higher, she didn’t get any extra cash, and thelender charged her nearly $20,000 in up-front fees to put her into a loan that didn’t help her at all

Lopez thought the accusations against Quality were unfair Quality did what it could to police theindependent brokers who were feeding it business, he said, but it could only do so much to protectconsumers from themselves “People will sign anything, sad to say,” he said Quality, Lopez

believed, was simply operating under the rules of the game at the time, which, more and more, were

being set by Wall Street and the investors who bought mortgage-backed investments “It wasn’t aconspiracy to cheat people,” he said “Wall Street tells you: ‘You make this loan, I’ll pay you a bunch

of money,’ so what do you do? If you don’t make the loan, you’re out of business.”

Quality wasn’t the only mortgage lender that was running into legal problems Lawsuits were

bubbling up around the country, attacking what consumer lawyers and neighborhood activists werebeginning to call “predatory lending.” The targets of these actions were the consumer-finance

companies that had shifted their focus from small personal loans to home-equity loans The biggesttarget was Fleet Finance, the Atlanta-based subsidiary of Fleet Financial Group, New England’s

largest bank Fleet Finance, the Boston Globe said, was the “jewel in the crown of its parent

company.” While Fleet Financial Group’s traditional banking operations were bleeding red ink, itsconsumer-finance unit was pulling in profits of $60 million a year Wall Street helped Fleet put

together home-equity securitizations worth hundreds of millions of dollars each Fleet Finance took adifferent tack from Long Beach and Quality, both of which did larger-sized mortgages, focused oncash-out refinancings, and generally charged lower rates than consumer-finance lenders Fleet

Finance, in contrast, made its money by teaming up with mortgage brokers and home-improvementcontractors who were talking minority and low-income homeowners into taking out smaller

mortgages with interest rates of 15, 20, even 25 percent

In Atlanta, Fleet worked mainly with a group of seven mortgage brokers that consumer lawyersreferred to as “The Seven Dwarfs.” The brokers had written agreements to feed business to Fleet;many sold nearly all of their loans to the lender By operating in this way, consumer attorneys said,Fleet was insulating itself from legal claims over the slippery methods used to sell the loans to

unsophisticated borrowers Fleet said the brokers were completely distinct companies and that allbusiness dealings were done at arm’s length Ultimately, the lender argued, it was up to the

homeowners to make sure they got a fair deal “These people may be poor and illiterate, but no oneputs a gun to their head and tells them to sign,” a top Fleet official said “This idea that Fleet shouldregulate the world is preposterous.”

The charge against Fleet in Georgia was led by William Brennan Brennan had studied to be apriest but had decided, amid the turmoil of the 1960s, that he could do more good as a lawyer “Itseemed the whole world was going by and I was missing it, especially the civil rights movement,” heonce recalled In 1968 he joined Atlanta Legal Aid, a government-funded program that representedlow-income people In 1988 he started Atlanta Legal Aid’s Home Defense Program He became aone-man clearing house on the dark side of home loans, plying visiting reporters with photocopiedstacks of lawsuits documenting the growth of abusive lending Brennan worked late into the night and

on weekends, and had trouble turning down a client in trouble; he couldn’t say no, no matter how bighis caseload was Legal Aid lawyers see a steady stream of people who are abused by powerfulinstitutions It’s hard for lawyers not to shield themselves from their pain by sorting the victims intovarious patterns and categories But for Brennan, one colleague wrote, “[I]njustice was not a pattern

or a category Even if he had seen a particular case a thousands times before, he always gave theclient the impression that he had never seen anything like it The impression was more than a goodacting job I am convinced that in some profound way, Bill was always surprised at injustice.”